'Convergence' Remains a Pipe Dream as Convergent's IPO Approaches

The networker's IPO is set for the week of June 28, but voice-and-data convergence is far from a reality.
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SAN FRANCISCO -- Phil Kalin, chairman of Strategic Healthcare Solutions in Denver, was thrilled last September to hire Convergent Communications as a Johnny-on-the-spot to manage the telephone and computer wires at his 30-worker software company.

"We get one bill, with one price on it," says Kalin.

But when Convergent suggested taking the relationship a step further by handling Strategic's phone calls on its computer network, Kalin declined. "It just seemed far out," says Kalin. "I'm not sure the technology is there or is the most cost-effective yet."

Kalin's reluctance to "converge" his firm's voice and data networks, expressing an unease echoed by corporations nationwide, explains why Convergent isn't yet the story Wall Street expects. The Englewood, Colo.-based carrier is preparing to raise $115 million during the last week of June in an initial public offering underwritten by

Goldman Sachs

. Backed by

Cisco

(CSCO) - Get Report

, Convergent is growing robustly by lavishing attention and services on its small corporate clients. Experts laud its efforts to benefit from the growth of both telephone and data communications.

But Convergent continues to find convergence largely elusive. Even as its sales force touts the company's ability to mingle speech and digits on a single line, many customers are holding off. "You've got to be careful not to confuse the hype with the revenue picture," says one executive who works for an equipment supplier that competes with Cisco and who asked not to be named. Even in three years, he says, Convergent will be "a plain old phone company and a plain old" Internet service provider, rather than the convergence play Wall Street might be anticipating.

Officials with Convergent declined to comment for this story, citing an offering-related quiet period enforced by the

Securities and Exchange Commission

.

Cisco has big plans for Convergent, which a Cisco marketing vice president, Larry Lang, says will "pioneer a unique path to the new world." Cisco in April extended a six-year, $103.5 million line of credit to Convergent. In return, Convergent plans to install 50 Cisco switching systems on its nationwide network to handle data and eventually voice calls. Cisco also has a warrant to buy 1.1 million shares over three years, potentially giving it a 4% stake in the company.

Despite an aggressive sales campaign for converged voice, data and video services, the business hasn't exactly taken off. To date, less than 10% of Convergent's traffic actually is carried as converged voice-and-data signals. Pairing with Cisco, Convergent intends to change that this year.

The problem is, potential customers are still hesitant to sign up. One Convergent customer says he might test Internet calling in a year or more. But right now, he won't trust his phone calls to a data network. "If it's not working 100% all the time, I'm dead," says Michael Brown, technology director for

Yellow Transportation

, which runs taxis and shuttles through metro Denver.

Indeed, the key is reliability. While Internet users will forgive some outages of email service, they have come to expect 99.999% reliability on voice calls. Currently data networks, which send messages in individual packets and reassemble them at their destination, fall short of that standard in many cases.

Until customers believe Net telephony is reliable, they will continue to balk at combining voice and data lines. Given such reluctance, Convergent seems likely to keep hawking Cisco gear right alongside phone systems from

Lucent

(LU)

and

Nortel

(NT)

. While this strategy can fuel heady growth, it's not the

convergence investors might be expecting.

Convergence issues notwithstanding, Convergent is off to a good start. In the first quarter, revenue nearly quintupled from year-ago levels to $30.5 million, and gross margins rose to 34% from 26%. Convergent's net loss for the quarter expanded to $20.7 million from $5.1 million a year earlier, but Internet investors know that isn't unusual as a young company spends heavily to lay the groundwork for growth.

The company has so far declined to predict growth from converged services. Right now, its revenue is evenly split between services -- consulting and maintenance -- and communications-equipment reselling, areas that should themselves continue growing.

"I think the beauty of the story is that they've deployed intelligence ... in strategic areas," says Bruce Boland, president of

First Continental Group

, which owns 1.8 million shares, or 6%, of Convergent.

Already Convergent, founded in 1995 by its CEO John Evans and other veterans of the phone carrier

ICG Communications

(ICGX)

, has raised $204.5 million in private placements and offerings. After acquiring 14 companies, Convergent has seen its ranks swell to more than 1,000 employees.

First Continental's Boland, who first viewed the company as an Internet play, believes Convergent will come to earn its name. Internet telephone service is "becoming more important than I realized two years ago," Boland says. Still, he makes no prediction about the immediate prospects for revenue growth in that business.

Others agree that walking both sides of the line is wise. "If you have

just one or the other, you ignore important market opportunities," says J.B. Haller, director with the research firm

Current Analysis

in Stirling, Va. (Cisco is a client of Current Analysis.) Haller points out that

Qwest

(QWST)

, widely viewed as a telecommunications play with enormous potential in years to come, operates both voice and data networks.

But for now the name Convergent sounds, if not ironic, then premature.